In our 2016 Oil Price Outlook, we predicted that oil would gradually rise from $36 per barrel to approximately $60 per barrel.
What we saw was roughly in line with that forecast. WTI closed out the year at $53.75 per barrel.
Clearly, we didn't quite make it to $60 per barrel but I'd say there's a very good possibility that we'll get there in 2017. I wouldn't expect much beyond that though.
Production cuts from the world's biggest producers continue to key to the market.
After two years spent flooding the market with crude, OPEC has thrown in the towel. The group, led by top oil producer Saudi Arabia, cut production for the first time since 2008. It struck a deal with Russia, the largest non-OPEC producer, as well.
At the same time, many U.S. shale producers, which cut into OPEC's market share, have been driven out of business.
As a result, crude output is on course to contract, driving prices higher. How much higher depends on demand. That will be determined by the salience of global economic growth.
Indeed, demand is far harder to predict than supply, but there is reason to be optimistic.
The U.S. economy continues to solidify and grow, albeit at a modest pace. The European economy has struggled, but is bolstered by an extremely accommodative monetary policy. And China, which has accounted for most of the demand growth seen this millennium, will not allow its GDP growth to decelerate any further than it already has.
Hence our suggestion that oil prices will finally surpass $60 in 2017.
So let's take a closer look at the supply/demand picture, oil prices themselves, and stocks that could potentially benefit investors...
Supply & Demand
The decision by OPEC to cut production was inevitable for one simple reason: members' budgets demanded it.
Oil accounts for a whopping 92% of Saudi Arabia's budget. As a result, the Kingdom needs oil at $106 per barrel for its budget to break even. The only thing that's kept the lights on in the Desert Kingdom these past few years has been its huge stockpile of currency reserves.
Still, there's no hiding from low oil prices when crude production accounts for 57% of your GDP, as it does in Saudi Arabia. Beyond that, oil accounts for 30% of Iran's GDP, 30% of Kazakhstan's, 49% of Angola's, 42% of Oman's, 56% of Iraq's, 46% of Libya's, 30% of Algeria's, 67% of Congo's, 21% of Russia's, and 21% of Venezuela's.
Many of these countries also choose to spend that oil money rather than bank it.
Nigeria needs oil at $122 for its budget to break even, Venezuela needs it at $117, and Iran needs it at $130 per barrel. Russia, the largest non-OPEC producer, also requires $100 oil to buoy its budget, as it labors under sanctions and a recession.
So OPEC finally broke. The group's production totaled more than 33 million barrels per month in 2016. It's since fallen to roughly 29 million barrels per month.
It's hard to say exactly how much further output will drop (some members are prone to cheating), or at what pace. But at least now inventories can be siphoned down as the cartel works to push prices higher.
At least for a while...
If you remember, this whole thing started because Saudi Arabia wanted to hamstring American production by driving high-cost frackers out of the market. And it's done just that.
Roughly 100 North American oil and gas companies filed for bankruptcy amid crude's two-year price rout.
And U.S. oil production fell 5.8% in 2016, from 9.42 million barrels per day to 8.88 million barrels per day.
Of course, higher oil prices will mean a resurgence for U.S. drillers. We may not see the kind of production we did when oil was trading at $80, $90, or $100 per barrel but production will come back to some degree. However, that's probably more of a 2018 problem for oil prices than a 2017 problem. Indeed, U.S crude oil production is forecast to average 9.2 million bpd in 2017 and 9.7 million bpd in 2018, according to the EIA.
Global consumption, meanwhile, is expeted to rise from 98.15 million bpd in 2016 to 99.74 bpd in 2017.
Given that, it's fair to expect oil prices to rise further to $60 per barrel in 2017, but the market could run into some challenges as the year goes on. If U.S. production comes back faster than expected, if OPEC members cheat by over-producing, or if there's a significant drop in global economic activity (i.e. a major recession) oil prices could easily reverse course.
For investors, this sudden fall in oil prices has created a strong buying opportunity.
There are multiple ways to play a rebound.
First, there are ETFs. The United States Oil Fund (NYSE: USO) and the ProShares Ultra DJ-UBS Crude Oil ETF (NYSE: UCO) are two.
The former generally corresponds to any movement in the price of oil. But the latter is leveraged to provide twice the return of any oil price rise. That makes it a more dynamic play going forward.
Currently trading around $8 per share, the fund was trading at $40 when oil peaked last year. If and when oil returns to $100 per barrel, this ETF will deliver a generous return.
Oil companies are another way to go.
One company we like is EOG Resources (NYSE: EOG).
EOG is one of America’s biggest shale producers with prime positions in the Eagle Ford, Bakken, and Permian Basin. Its focus in recent years has been on streamlining operations to boost drilling returns so that it can thrive on lower oil prices.
And it’s largely succeeded.
EOG has pushed costs down and output up. The net result is that it controls a vast inventory of premium wells, which are those it can drill to earn a 30% rate of return at $40 oil.
With oil over $50 per barrel, the returns on EOG Resources' premium wells double to 60%. As a result, the company can generate more cash flow, which puts it in the position to deliver 10% compound annual oil production growth through 2020.
The consensus analyst estimate is for EOG to earn EPS of $0.18 for the year 2017. The high range of forecast is $1.03. It also pays a dividend of $0.17 per share, yielding 0.71%.
Another much smaller producer to keep an eye on is Contango Oil & Gas (NYSE: MCF).
Contango Oil & Gas Co. is a Houston, Texas-based company that operates in the Texas Gulf Coast and Rocky Mountain regions of the U.S. Its proven reserves total 37.7 million barrels of oil equivalent. And there’s more potential in the company’s shale holdings throughout Texas and Wyoming.
It doesn’t have very much debt, either — just 1.4x earnings — and like EOG, it has been working to cut costs.
The stock surged some 60% in 2016 and still has room to grow.
Investors might also look to pipeline companies.
Kinder Morgan (NYSE: KMI), for instance, is the largest energy infrastructure company in North America. It controls 84,000 miles of pipelines and 180 terminals.
Here’s what that looks like...
Because it’s primarily engaged in energy transport and storage, KMI is less beholden to oil prices than it is volume. And volume remains relatively robust, even with a slight drop-off in U.S. production.
Interestingly, both George Soros and Warren Buffett are buying heavy into KMI.
Soros owns a stake of 50,700 shares, worth about $887,000 right now. And Buffett's Berkshire Hathaway recently unveiled a $400 million stake in the company.
It’s not hard to see why. KMI’s 2016 budget guidance projects $4.7 billion in diversified cash flow, with $3.6 billion of cash going to dividends. It also outlined $3.3 billion in capex expansions, JV contributions, and acquisitions.
EBDA are estimated at $8 billion and EBITDA at $7.5 billion.
And that budget only assumes oil prices at $38 per barrel on average. Every $1 in change results in a $6.5 million DCF impact. That comes out to $130 million total if oil reaches $58 per barrel.
Magellan Midstream Partners (NYSE: MMP) is another good pipeline company.
Magellan has 1,600 miles of crude oil pipelines and storage facilities with an aggregate storage capacity of approximately 21 million barrels, of which 12 million are used for leased storage.
Additionally, it has five marine storage terminals with an aggregate capacity of 26 million barrels. That's beneficial because storage is in high demand right now.
The operating margin of Magellan's crude oil segment recently increased by $33.4 million, to $106.9 million. That enabled the company to raise its full-year guidance for distributable cash flow by $10 million to $880 million.
In addition to its crude assets, Magellan has a 9,500-mile refined products pipeline system with 53 terminals. That's key, since U.S. exports of refined products are at their highest level in years.
Refiners are exporting 3.52 million barrels a day, up from 2.77 million in 2014 and 1.78 million in 2009. Roughly two-thirds, or about 2.5 million barrels, of those exports go to Canada, Mexico, or Latin America, making the U.S. the premier refining hub of the Western Hemisphere.
All of these stocks are primed for a stellar year.
Don’t miss out.
The Outsider Club Research Team